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The Best Investing Style ETF This Fiscal?

A debate between different styles of investing is not new to the financial world. There are various ‘experts’ from different schools of thought with strong arguments poised in favor of their beliefs as far as investment styles are concerned. Whether undervalued stocks have the potential to deliver high returns (value style) or overvalued stocks make for a good momentum play (growth style) or a combination of both flavors in a portfolio is a winner (blend style) has been and will be a never ending discussion.

Nevertheless, while there are pros and cons associated with each investing style, it is also true that the same strategy or style doesn’t work for different market conditions. Having said this, a look at the best performing investment style this fiscal year is prudent especially as we near the conclusion of yet another economically action packed year. (see 3 Emerging Market ETFs Protected from Global Events)

The methodology adopted was selecting nine ETFs, each ETF representing a particular investment style and a market capitalization bucket (i.e. large, mid or small). To compute the results we have assumed that an investor allocated capital uniformly across the entire spectrum of market capitalization, thereby focusing solely on the investment style and eliminating any market capitalization bias. (read Mid Cap ETF Investing 101)

The portfolio returns and risk is computed assuming that the investor allocates equally across the three types of ETF for any particular style. In other words, the weight allocated to each ETF across a particular style is 33.33%.

The following table summarizes the results obtained for each style box.

Not surprisingly, the volatility tends to increase towards the small cap ETFs. Of course, this is quite expected as mid and small caps are more volatile than their large cap counterparts. This is especially true considering the volatility that we have witnessed over the past twelve months, first over the Eurozone issues and now over the impending fiscal cliff. However, the small caps have fared better in terms of absolute returns. (see more in the Zacks ETF Center)

Instead of concentrating on absolute performance, our exercise focuses on risk-adjusted performance. In other words, it takes into consideration the reward reaped by an investor for bearing up with the volatility of the investing style chosen by him/her.

The table summarizes the trailing performance of each style on the basis of their risk-adjusted returns. In order to compute this, the portfolio returns and risk were calculated, and the return was divided by the risk obtained. Based on this score the various styles were ranked.

As we can see, the value ETF portfolio has performed better, both in terms of absolute portfolio returns as well as risk adjusted returns, than its growth and blend counterparts, having a return per unit of risk score of 0.96. Compared to this, the growth portfolio has a score of 0.83 while the blend portfolio got a score of 0.74.

Also, the value ETF portfolio has exhibited less volatility than the growth and blend portfolios as indicated by lower portfolio volatility (read SPDR Files for Low Volatility ETFs).

Growth investing is basically a momentum play; this makes it a great strategy in a trending market (i.e. a market characterized by a prolonged up or downtrend). This is because stocks in the growth ETF portfolio harness their momentum in earnings to create a positive bias in the market which results in rocketing share prices. However, this only works when the broader market sentiments have a predetermined direction.

However, in the last 12 months the markets have seen movement in a quarterly up-down-up-down trend making it virtually impossible to predict a trend, at least this was the case for a good period of time this fiscal (read What Do Quarterly Trends Reveal about ETFs in Q4?). However, this doesn’t mean that growth stocks underperform during such markets.

However it does mean that they exhibit a higher degree of volatility especially compared to value stocks. This is the primary reason why growth stocks have a lower risk adjusted return performance, although in terms of absolute returns there seems to be hardly any difference between the three styles.

On the other hand, value stocks are not very susceptible to the trending markets unlike their growth counterparts. They give the market ample time to find and realize the potential of these companies with hidden value. This makes them less susceptible to the broader market conditions. This also results in a lower realized volatility as indicated by the figures in the table. Therefore in a volatile market these make for great picks for highest risk adjusted returns. (see ETFs in a QE3 World)

Nevertheless, each investing style has its own advantages and disadvantages and it entirely depends on the individual investor’s risk-return profile as to which style is best suited for him/her. However, with 2013 poised to be yet another action packed year ahead of the fiscal cliff one might think that in order to seek investments with higher risk-adjusted returns, value ETFs might well be the place to be.

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At the center of everything we do is a strong commitment to independent research and sharing its profitable discoveries with investors. This dedication to giving investors a trading advantage led to the creation of our proven Zacks Rank stock-rating system. Since 1988 it has more than doubled the S&P 500 with an average gain of +25% per year. These returns cover a period from 1988-2017. Zacks Rank stock-rating system returns are computed monthly based on the beginning of the month and end of the month Zacks Rank stock prices plus any dividends received during that particular month. A simple, equally-weighted average return of all Zacks Rank stocks is calculated to determine the monthly return. The monthly returns are then compounded to arrive at the annual return. Only Zacks Rank stocks included in Zacks hypothetical portfolios at the beginning of each month are included in the return calculations. Zack Ranks stocks can, and often do, change throughout the month. Certain Zacks Rank stocks for which no month-end price was available, pricing information was not collected, or for certain other reasons have been excluded from these return calculations.

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